Rather than view a potential recession as something you can only “ride out,” seize the moment to drive changes that will reduce operating spend and free up cash for projects that will create competitive advantage.
A slowdown in economic growth normally means weaker customer demand, lower margins, reduced profitability, and lower free cash flow. Your industry sector, global revenue diversification, and capitalization strategy will dictate your individual circumstance and corresponding actions. As a global strategic advisory firm, The Hackett Group believes the following actions are critical considerations, whose priority will be determined by circumstance.
The Hackett Group’s recommendations fall into two general categories:
• Inefficiency kills competitiveness. In order to maintain profitability and cash flow in times of weaker demand and margin pressure, it is imperative to understand and target inefficiencies throughout the organization. Some combination of both rapid and strategic cost reduction initiatives is critical to short-term results, as well as long-term competitiveness.
• Cash is king. Freeing up unnecessary working capital is the cheapest form of financing. During periods of economic growth, the focus on the balance sheet wanes, leading to increased inventories, receivables, and inefficient management of sourcing relationships and payables.
Rather than view the current economic downturn as something that you can only “ride out,” seize the moment and use the sense of urgency created by it to drive changes in the organization that will quickly reduce operating spend to appropriate levels and free up cash, which can then be invested in projects that will create competitive advantage. Change usually happens on the back of a major disruptive event, like the housing meltdown, and we are generally in a recession long before it is acknowledged in reported GDP data. Seize this moment, and use it to drive change. It is amazing how many improvement initiatives have their origin in a compelling event that forces buy-in from executive management, line workers, and other stakeholders.
World-Class Operation
The best preparation for being able to recognize and exploit opportunity is to implement world-class performance programs. When times are good, it is easy to overlook many cost-saving opportunities in back-office functions, since many of the changes required to harvest these savings are challenging and far from sexy, compared with other core business opportunities. We continue to see the gap widen between the industry peer-group averages and those companies that perform at world-class levels (Fig. 1).
A combination of rapid and long-term strategic cost-reduction initiatives can yield hard dollar savings that drop almost immediately to the bottom line and represent permanent cash/profit savings.
• Identify immediate opportunities for near-term cost reduction by taking a fact-based approach to what other leading companies have achieved. This is not sitting around the conference room determining what across-the-board costs you plan to take out. Rather, this is a thoughtful exercise based upon reliable performance metrics, by both function and process, which illustrates where you have excessive cost.
• Up the ante on shared services. If there is any single business practice that has
resulted in dramatic cost savings for G&A functions, it has been the implementation of the shared services business model. The shared services model leverages two sound principles in effective cost reduction: scale leverage and standardization. Our 2007 Global Shared Services study found that 65 percent of firms implementing shared services achieved savings in excess of 20 percent of costs, while 27 percent actually achieved savings in excess of 40 percent.
• Recognize the implications of the services globalization mega-trend on all back-office processes, and implement strategies to move this work from high-cost to low-cost regions. Globalization of work is no longer a leading-edge strategy; it should be considered a best practice for any company striving to achieve world-class performance. The Hackett Group has determined that the typical, $22-billion Global 1000 company has a minimum of $120 million in labor arbitrage savings if it were to fully implement a globalization strategy in its core G&A processes.
Next, take a long look at tackling the more strategic transformation projects. Focus on projects that will ensure that the company’s G&A functions are operating at world-class levels in both efficiency and effectiveness. This strategy will yield a greater payoff than simply reducing labor costs. World-class performers can eliminate labor when processes and technology are optimized and complexity is reduced. Hackett research has shown that the typical Global 1000 company can save $189 million when globalization efforts are combined with world-class transformation initiatives.
In These Times of Financial Uncertainty, Cash Is King Again
Freeing up excess working capital is the cheapest form of financing. Therefore, know where the hidden piggy banks are buried within your organization. According to REL, the working capital division of The Hackett Group, there is a tremendous amount of cash unnecessarily tied up in the typical company’s working capital. Indeed, the typical $22 billion Global 1000 company has an average of $2.9 billion in excess working capital, compared with companies that have achieved upper-quartile performance in their industries (Fig. 2).
Start by looking at cash flow opportunities presented by inventory, payables and receivables. This is an area of almost unlimited possibilities, many of which can produce very actionable items for improving cash positions. Even modest adjustments to cash payments can help stabilize an organization.
• Perform a detailed analysis of the entire customer payment process, beginning with the initial terms and conditions that were established during the sale. It is critical to understand the gap between when customers should pay and when they actually do pay. You need to fully understand the root causes of why customers pay late.
• Review your inventory and inventory strategy. It is startling how quickly slow-moving items can escalate the level of inventory and resulting cash tied up in an unproductive use. Establish a process to systemically review the inventory turns of key products.
• Review your existing supply base, and look to consolidate your spend and increase your buying power. Then leverage this to negotiate more favorable costs, terms, discounts, service, lead times, and quality.
Next, review your sourcing strategy. Any organization that must compete globally must make its sourcing strategy a top priority. The global market is changing so fast that a thorough evaluation of your supply chain done just two or three years ago may be out of date today.
From a sourcing perspective, it is very difficult to ignore the cost savings available from sourcing products/parts from low-cost regions, especially Asia. However, a word of caution for this strategy: REL’s research has shown that companies that have successfully reduced their cost of goods sold (COGS) and attained their desired gross margin improvements have also experienced increases in inventory levels. In other words, companies are buying/making cheaper products, but due to the massive increase in distance and lead time, have many more units of product in their supply chain.
Globalization from both sourcing/making products in low-cost countries to ship to major western markets as well as supply a fast-growing new base of customers in Asia will be a significant challenge. This is not just from a quality-control perspective, but it is also difficult to reap greater rewards from this sourcing opportunity so that you do not just pick up gross margin gains. It can simultaneously reduce inventory levels and improve order fill rates to your customers. The challenge can be boiled down to three broad areas: demand forecasting; speed across the supply chain, including physical manufacturing, shipping, and planning lead times; and supply chain flexibility.
Another equally rewarding theme of advanced working capital optimization involves collaborative working capital. This is where there is a much closer relationship between your company, your customers, and your suppliers. The basic premise of this approach is getting the best possible visibility of “true demand” – something that in most cases is nothing like the ordering pattern that you receive from your customers.
Strategic Implications
The Hackett Group’s message of the power of world-class performance, always important in times of economic growth, has even more applicability during market downturns and in times of economic uncertainty. The best companies not only survive during these times; they position themselves to take advantage of opportunities as the market improves. As the data from our benchmarks and other studies shows, top-performing companies consistently invest in their people, processes and technology to differentiate themselves from the rest of the pack, in good times and bad. In an increasingly competitive global environment, the margin between winners and losers might well come down to the efficiency of the G&A areas as well as the effectiveness of these groups and their ability to positively impact the overall business. FAO
By Bryan Hall, Michel Janssen, Stephen M. Payne, & Wayne Mincey. Bryan Hall is practice leader, finance executive advisory program, The Hackett Group. Michel Janssen is chief research officer, The Hackett Group. Stephen M. Payne is president, REL, responsible for all aspects of The Hackett Group’s global business. Wayne Mincey is president, The Hackett Group. Courtesy - FAO Today
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